The Virgin Media appeal has been dismissed by the Court of Appeal, leading to potential costs for scheme employers, who should get involved in trustee discussions to assess the scale of this issue for their own scheme and ensure the right steps are taken to minimise it.

What is the Virgin Media case about?

The Virgin Media case relates to defined benefit pension schemes which were contracted-out of the State earnings related pension on a salary-related basis between 1997 and 2016. The case revolves around the exact legal requirements to make valid changes to benefit rules for these schemes. The issue is called “the s37 issue” named after the legal section it is derived from.

There has been uncertainty for years about precisely what s37 meant, in particular whether the s37 requirements applied to only past service benefit changes, only future service benefit changes or both. The Court of Appeal has confirmed the High Court decision that s37 catches both past and future service benefit changes.

In order for a pension scheme to make legally effective changes to benefit rules between 1997 and 2016 the scheme actuary had to confirm in writing to the trustees that the statutory contracting-out test continued to be met after the changes were made.

The High Court confirmed that s37 applied to both improvements and reductions to benefits. It also confirmed the impact of no s37 confirmation being obtained when needed is that the benefit changes are void regardless of whether the scheme was capable of meeting the s37 test. These points were not appealed.

Why is this of concern?

Many schemes do not have a perfect set of documents with s37 confirmations attached.

During the 1990s and 2000s the focus tended to be on the quality of the benefits provided for s37 purposes, not the attendant paperwork. This means that the obvious evidence of compliance with s37 requirements is not as prevalent as one would expect given the legal consequences of no confirmation being given.

The compliance evidence gap calling into question the validity of benefit changes is more of an issue where future service benefits were being reduced which was common at the time. Improvements can be corrected retrospectively; reductions cannot.

Closure to accrual is of particular concern as the interaction between s37 and closure to accrual remains unclear.

Why is there still uncertainty?

We now know when a s37 confirmation was required. Whether it was obtained is a matter of evidence. The best evidence is a signed s37 confirmation from the scheme actuary to the trustees dated before the effective date of the changes and appended to the amending document.

However the best evidence is not always available. In our experience it would have been outside market practice to amend rules without actuarial input. The need to provide benefits that met the contracting-out test was well understood and set out in the actuarial profession’s guidance called “GN28” (as amended over time). Sometimes the amending documents refer to s37 compliance, sometimes not. Archived files can contain correspondence between the actuary and the trustees which points to compliance being done, even though there is no neat self-contained confirmation. Sometimes nothing survives except recollections of the parties involved that the scheme actuary was actively involved in the scheme affairs including benefit changes.

Amendments are not automatically void because the confirmation cannot be produced. The question for trustees is whether a sufficient body of evidence survives to suggest on balance of probabilities that a s37 confirmation was given despite the fact that the document itself does not survive. If there is then trustees may well be comfortable to treat changes as valid, recognising that there is some risk of challenge to that view.

Why is this relevant to sponsors?

Whilst the trustees lead on this issue because it could impact on the benefits members are entitled to, the sponsor has an interest in the outcome of any review. After all, if any part of the benefit changes is found to be invalid, it is the sponsor who will ultimately meet the costs of any such invalidity.

Many trustees and sponsors have taken a “wait and see” approach until now but the dismissal of the appeal may have shifted the balance of risk towards trustees undertaking an initial fact find of what the amending documents show (if this has not already been done). If this shows there is doubt, that can be followed by focussed and sensible levels of investigation on what survives in the archived files for the benefit changes which present the key risks and cannot be easily corrected. Sponsor input is important as it may hold internal files which can provide useful evidence around benefit changes. Even where it is trustees who are holding files, sponsor views should be considered before trustees make a decision about the evidence.

As the party which in many cases will end up meeting any extra costs, it should be involved in the process which looks at the risk of benefit changes being invalid. One risk of a wait and see policy is the loss of an opportunity to recover against former advisers, if there is loss caused by breach of duty on their part. Claims can become statute -barred as a result of delay. This kind of claim is rarely open and shut. Few trustees want to sue their advisers, current or former, but we are already starting to see standstill agreements being requested sometimes at the request of sponsors who ultimately foot the bill for past errors.

After the High Court decision some auditors to sponsors started to ask for indications of the likely financial impact of s37 issues. Now the appeal is concluded, the pressure to “put a number on the issue” could arise again, but unlike other pensions issues like GMP equalisation where “guestimates” are possible, s37 is very scheme specific. The level of risk and potential cost can be anything between nil and terrible and only a high level review of the documents will give any indication of the true picture for each scheme. Employers are likely to want actuarial advice to quantify the potential issue for their own scheme.

Will the Government fix the problem?

There is still hope that the DWP will intervene to remove the uncertainty. There is a statutory power which could be used to remove the unintended consequences of the way s37 operates. The purpose of the contracting-out legislation was to ensure that members got good enough benefits in return for the reduction in their State pension. It makes no sense for rule changes to be invalidated if the benefits were in fact good enough to meet the contracting-out requirements. But even if the DWP is minded to act, this may not be a quick solution to a long running issue.

With the Court of Appeal’s decision on the Virgin Media s37 issue, it’s time for scheme employers and trustees to start to assess the impact of this case on their salary-related contracted-out defined benefit pension schemes. If you’re facing uncertainty around your pension scheme’s compliance with s37 requirements, we can help you to explore your options in a sensible and risk-assessed way.